UK: Contracting Strategies And The Impact Of Brexit - Paper 2

With a process now developing for resolving some of the
political and constitutional issues raised by the outcome of the
referendum, the general decision in the industry to avoid panic
seems to have been the correct one.

We still have lots of uncertainty – that hasn't
changed – but most projects will have to continue over the
coming months with the parties fully bound in to the terms they
agreed at the outset. As promised in our
introductory paper, assuming that a project has not been
suspended or cancelled (which we covered in our paper of
June 30), we now turn to the short/medium impact of the
referendum and strategies relating to projects which are still
being delivered.

Labour/Inflation

The first issue is the impact upon the cost of delivering a
construction contract. Unless there is a very significant and
immediate reduction in the activity levels in the industry (perhaps
through suspensions, cancellations and mothballing new projects
– see the previous paper) it seems likely that there will be
no immediate general downwards pressure on the cost of
delivery.

Issues of skilled labour from the EU touch upon various aspects
of the industry. It now seems fairly certain that no-one is being
'sent home' in the near future; any contraction in the
supply of skilled labour in the short term (and perhaps over the
next 2 years, which should see many projects to a conclusion) is
likely to be caused by a drop in the influx of new workers and
individuals presently in the UK changing their plans and finding
work elsewhere in the EU. The driving forces of these effects will
probably be uncertainty (why make your home in the UK when you
could make it elsewhere in the 'rich' parts of the EU, and
have better security of tenure?) and the comparative lack of buying
power of Sterling when compared to the Euro when remitted to their
home countries. This is of course the very essence of the free
movement of labour.

A reduction in the supply of skilled labour (without any
corresponding decrease in activity levels) will likely have two key
effects. First, the price of skilled labour may rise as the same
number of projects chase fewer people. Second, as we saw over the
last couple of years, there may be a real impact on the
deliverability of projects where a steady stream of key trades
might not be available. This may lead to the familiar disputes
regarding the real reasons for projects going over schedule and
over budget, i.e. claims for liquidated damages from employers and
claims for loss and expense by contractors.

A more immediate effect on the cost of performing contracts will
be inflation in the cost of plant and materials to be imported from
overseas. At the time of writing, and comparing the 1 June 2016 to
the 1 July 2016, the pound has lost 10% of its value against the US
dollar and the Euro. It seems unlikely that the pound will bounce
back any time soon. Those contractors who are fortunate enough to
have agreed fixed prices in sterling with their overseas suppliers
might be sufficiently insulated from the fall in value. Equally
those who negotiated payment in a currency other than sterling, or
who agree helpful fluctuation options (see for instance Schedule 7
of JCT DB 2011) may find themselves protected. The remainder under
lump sum contracts, or those with agreed rates, will find
themselves stuck in the middle and bearing the consequences of the
devaluation of sterling unless they can rely upon any contractual
methods of relief.

What Can a Contractor Do?

Probably not a great deal. However, here are a few things to
think about.

Laissez Faire contracting

The starting point is that a contractor who has agreed to
perform a contract for a lump sum, or on agreed rates, is going to
carry the risk of a shortage of labour in the market or an increase
in expense. English law is known for being very 'laissez
faire'. Although this sounds elegant, in reality it means that
the courts will not generally interfere with, or rewrite, a bargain
that was bad or that became bad as a consequence of changing
circumstances. Commercial, political or economic issues are
unlikely to lead to the termination of the contract for frustration
i.e. the doctrine which may release the parties from their
obligations under a contract if subsequent events mean that the
contract is no longer capable of performance. The attitude of the
Courts is that the contractor took the risk of delivering a project
for an agreed sum/at agreed rates, and so the Court will not
release him from that obligation. The corollary is that if exchange
rates moved in the contractor's favour, the employer would not
be able to appropriate any of this benefit either.

Force Majeure

Equally, although all standard form contracts contain 'force
majeure' clauses, which effectively forgive non-performance for
a time caused by extreme events, it is unlikely that a contractor
will be able to rely upon those provisions just because of a
general shortage of labour in the market or an increase in expense.
JCT DB 2011 provides that "force majeure" (uncapitalised
and undefined) is a Relevant Event (allowing relief in time, but
not money) does not attempt to give any definition to this phrase.
It is notable that other events that might often be thought of as
"force majeure" events are expressly referred to as
separate relevant events (for instance war, strikes, exceptionally
adverse weather) and so "force majeure" must naturally
mean something additional to those matters. Although English Courts
have always been reluctant to provide relief to contracting parties
when the circumstances of performance change, it is not beyond
contemplation that in extreme circumstances a rapid contraction in
labour (perhaps caused by a policy of repatriation of EU workers)
may fall within this category, particularly if this was not
foreseeable at the time of contracting.

In a similar vein, Clause 2.26.13 of the JCT says that "the
exercise after the Base Date by the United Kingdom Government of
any statutory power which directly affects the execution of the
Works" is also a Relevant Event. Could the implementation of a
government decision to leave the EU, thereby closing down access to
free movement of labour overnight, be said to "directly affect
the execution of the Works"? Quite possibly. If so could
lesser exercises of statutory power relating to the referendum
raise similar issues?

That Sounds Defeatist - What Might Contractors Do?

The reality is that sub-contractors will often seek to claim
their increased costs caused by this effect against main
contractors. In turn, main contractors may seek to pass up the
increases in costs to the employer. We have spent the last two
years dealing with disputes which were often driven by the
strengthening of bargaining position of sub-contractors, suppliers
and trades over time; jobs bid for in 2012/2013 based on the (then)
current availability of resources/market prices have often proved
to be undeliverable by main contractors on time and on budget when
the sub-contracting market had changed by 2014/2015. This effect
caught many main contractors short, eradicating their profit margin
and often meaning that the project would be delivered at a
loss.

A Shortcut

Over 2014 and into 2015, a development in the law opened
opportunities for contractors to use the payment mechanism to
substantially improve their position.

In essence, contractors would identify loss and expense as lump
sums in their interim accounts. These were often expressed as line
items with little or no support. In the normal course such claims
would be simply rejected by the employer/contract administrator as
being unsupported, and the loss and expense items would generally
be held over until the end of the project/the final account where
it might be supported, argued over, adjudicated upon or agreed,
along with any corresponding claims for liquidated damages for
delay.

The case of ISG v Seevic (2014) changed all of this. In that
case it was found that under both the JCT form and under the
provisions of the HGCRA (as amended), should an employer/contract
administrator fail to issue a Payment Notice within the very strict
timelines set out by the HGCRA, the face value of the
contractor's application is established as the value of that
interim payment. In the absence of an effective Pay Less Notice
(which also must be served within a strict timeframe), this sum
became due as a debt. There was no power for the Court or
Adjudicator to look at the true value of the interim application
– the contractor would be entitled to be paid his claim for
loss and expense in full, along with the rest of his
application.

So why not simply claw back the overpayment in the next interim
payment cycle? This is not as easy as it seems. While the NEC3 form
does allow for an overpayment in one month to be corrected by a
repayment from the contractor the next, it is arguable that the
unamended JCT form does not. Under the JCT form, the employer
arguably must wait until the final adjustment/final certificate
process is complete – this only occurs after the end of the
defects liability period, leaving an employer without his money for
perhaps a year or more. This commercial disadvantage has often led
to settlements on terms beneficial to contractors, who often will
never be put to the trouble of having to prove or support their
claim for loss and expense.

Trends

Over the last 2 years following ISG v
Seevic we have seen the following trends:

Contractors and subcontractors are
becoming increasing ambitious in the sums claimed in their interim
accounts. Whilst the first few cases contain loss and expense line
items in the sums of hundreds of thousands pounds or just breaching
one million, we now regularly see loss and expense claims which add
50 to 100% to the original value of the works.

Employers/contract administrators are
becoming increasingly aware of this issue and the need to meet the
very strict terms of the payment mechanism.

In turn, often denied the easy win
caused by the employer simply forgetting to respond in time,
contractors are deploying increasingly sophisticated arguments to
pursue their application. We now regularly see projects where
gaps/mismatches between the provisions of the contract and the
strict requirements of the HGCRA (as amended) allow the contractor
to pursue arguments that the monies applied for are payable on
their face, even where the employer has met the requirements of the
payment mechanism set out in the contract in every respect. This
'gap' has often been caused by well-meaning attempts to
lengthen the period of time for payment, or to introduce new
elements to the process (for instance the requirement for the
contractor to issue an invoice). Other fertile grounds for these
arguments include drafting issues with Payment and Pay Less
Notices.

The Courts have continued to apply
the principle in ISG v Seevic in respect of interim applications,
although a new principle has emerged to mitigate the strict effect
of this rule in the harshest of circumstances. For instance, where
the contractor succeeded generally on its argument in Galliford Try
v Estura (2015) the Court believed in all the circumstances that to
order payment of the amount in full would be unacceptably harsh
– it would amount to a 'manifest injustice'. In those
special circumstances the employer was only forced to pay part of
the awarded monies initially, pending the determination of the
final account.

It may be the case that this
principle of 'manifest injustice' is ripe for extension,
particularly in circumstances where the value of contractors'
interim applications become ever more ambitious, possibly to the
point where they over-reach themselves.

The Court of Appeal in Harding v
Paice (2015) has also caused some pause for thought. In that case
the court of Appeal declined to apply the strict rule in ISG v
Seevic (which related to interim applications, ultimately governed
by the HGCRA) in circumstances where there was a contractual final
accounting exercise following the termination of the project (i.e.
a payment process not governed by the HGCRA). It is notable in that
case that the Court of Appeal declined to either endorse or
criticise the decision in ISG v Seevic and it may be that this
principle is also due to be tested in the Court of Appeal at some
point.

We had already anticipated seeing many more of these disputes
before the referendum but it must be the case that any losses
caused by inflation or delay/disruption following the outcome of
the referendum may well find themselves into sub-contractor and
main contractor's accounts. The current law lends itself to
extremely strategic behaviour and very technical arguments.
However, from a paying party's perspective (whether employer or
contractor) there are always arguments and/or strategies that might
be deployed to respond to these types of claims, along with
opportunities for settlement. However, the key to avoiding these
claims is to make sure that the payment mechanism is followed to
the letter (assuming that it complies with the HGCRA) and to be
alert to signs that such a claim is coming act before it is too
late - for instance a significant jump in the claim for loss and
expense around or after practical completion is a real red
flag.

In our final paper we shall look at strategies to employ when
things go really wrong i.e. where insolvency creeps into the supply
chain.

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On 27 June 2017, the FCA published a policy statement (PS17/13) outlining new rules to be added to the FCA Handbook to prohibit contractual clauses that restrict competition without providing clear benefits...

An assignment of rights under a contract is normally restricted to the benefit of the contract. Where a party wishes to transfer both the benefit and burden of the contract this generally needs to be done by way of a novation.

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